Biggest disappointment from Infy is guidance: Cowen & Co

According to Moshe Katri, managing director of Cowen & Co, the biggest disappointment in Infosys’ Q1FY13 numbers was the guidance for revenue growth.

In an interview to CMBC-TV18, Khatri said the biggest question forward is what more from here. “An uncertain environment, based on the rule of thumb, will impact discretionary spending,” he said.

On the positive side, Khatri points out that second group to IT majors have done pretty well despite the weak environment.

Don't miss: Infosys' tanks on Q1 results, FY guidance disappointment

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee.

Q: There has been a big reaction here to that 5% dollar revenue guidance the company is talking about. How would you approach it now and how much would you scale down your own expectations by?

A: There is definitely a divergence in performances between a couple of players that are struggling, especially if you look at the tier 1. Infosys and probably Wipro you can include them in the same category. On the other hand, you do have the other part, the other group that is doing well such as TCS, Accenture and Cognizant that are gaining a larger share in a pretty tough environment.

Infosys is going through some transformational issues, some structural issues and I am assuming that in a tough environment the successors of these initiatives that they are going through will partly take longer to materialize. I think this is something that you are seeing. The environment is not great, there is no doubt about that, and the big question here is whether it gets worse from here or it continues to be pretty uncertain. An uncertain environment, based on the rule of thumb, will impact discretionary spending.

The biggest issue in Infosys' numbers from today is obviously the guidance. Infosys did provide some hints during a conference call couple of weeks ago indicating that the main environment was getting worse, especially in the BFSI. They cited some budgets in financial services that are being scaled back again by 20-25%. We don't know if it is a widespread phenomena right now or this is specific to Infosys, but we do need to listen to Infosys. They are probably continue to be cautious. It is really difficult to say rationally where this industry is going to go.

The good news is that TCS is reporting today as well. TCS in my view made the right decision to come out with numbers in a way potentially to not to let the majority of discussion related to IT spending or IT services come out based on Infosys' numbers. If TCS’ results come out mildly better, they will probably continue to be cautious and I think with the direction in terms of where the discussion is going to go is going to shift, from one extreme maybe to the middle. The demand environment is stuck, it is still early to know whether it is going to get tougher, but again the key is going to be TCS' numbers.

Q: Should one go with the premise that Infosys’ company specific problems, not withstanding the weakish demand environment that you are talking about, will be a headwind for most of the IT companies this year? Or is it really very disparate between companies and you should not draw that influence which has a mild de-rating kind of takeaway for the entire sector at large?

A: Good news is that we have had Accenture reporting couple of weeks ago. Accenture had decent numbers and strong growth which mitigated the impact of a slowdown in the consulting business. They are doing relatively well, so I think you can probably look at a scenario right now where the market continues to believe in this hope that there is definitely polarization that’s going on between the two groups of players. Whether the scenario gets worst for everybody really depends on the macro.

I think you are seeing two different groups of investors right now in the market that we talk to. The group that does care about fundamentals, that will tell you that some names are really cheap right now. From a long term fundamental perspective, given the fact that their secular growth range remains pretty decent, it is probably good time to continue to accumulate these names. Then you have another group that says that some of these names are pretty inexpensive, but if we get to the spending freeze that we did get to in the 2007-08 timeframe, back then the multiples bottomed at eight times earnings. Based on that there is significantly more upside and I think these are two very different groups that kind of looking at this industry right now.

Q: What to your mind is the problem with Infosys? Is it client specific? Is there some flaw in their strategy that you can see? Is it really a spending freeze across IT budget which is haunting them? Can you put your finger on the problem?

A: I think some of it is client specific. We have to look at sequential growth from top five and top 10. There are some issues, but it maybe a bit of everything. Client specific issues, the impact of the restructuring that’s going on and I think when you are going through such a tough environment, it is really difficult go through these restructuring initiatives and see immediate results. I think it is going to take time.

I don’t think Infosys is going to go away but I think that they will slowly come back to the low but again you do have to build that credibility with the investor base. It is difficult to come out on a quarterly basis with  these numbers and this guidance. So, it’s going to take time.

Q: What do you do with something like a TCS by contrast where performance has been strong but valuations are pretty expensive? Given a choice between the two - would you still think that money will move towards TCS rather than Infosys?

A: It’s a great question. Before the earnings release, in our preview we kind of stated what investors felt about Infosys and conversations with numerous investors kind of tell us that investors felt that Infosys stock is a broken stock, has no credibility. We are getting into this quarter with various expectations and obviously expectations were not lower enough.

 

Based on what heard, as I understood, investors were actually shorting stocks with high expectations such as Cognizant and TCS. So, from my perspective, we do want to focus on the winners in the cycle. Again, we like Accenture, we like Cognizant, we don’t follow TCS but obviously in our view TCS continues to do remarkable well in this difficult environment.

 

But the buy side had a very different point of view getting into this quarter which is maybe we should start buying Infosys because expectations were so low and the stock was cheap. They have about seven bucks in cash per share. On the other hand let’s short some of the stocks that have some very high expectations like Cognizant, Accenture and even probably TCS. Obviously at this point, this is probably strategy that backfired